Business Context and Reporting Period
Company: HMS Income Fund, Inc. (a Business Development Company and Regulated Investment Company)
Reporting Period: Quarter and nine months ended September 30, 2015
Business Model: Externally managed closed-end fund investing primarily in debt and equity securities of lower middle market and middle market companies. The fund utilizes leverage to enhance returns and pays regular distributions to shareholders.
Key Financial Metrics
| Metric (in thousands, except per share) | 9 Months Ended Sep 30, 2015 | 9 Months Ended Sep 30, 2014 | As of Sep 30, 2015 |
|---|---|---|---|
| Total Portfolio Investments (Fair Value) | $876,697 | $363,654 | $876,697 |
| Net Investment Income | $24,661 | $6,343 | N/A |
| Net Increase in Net Assets from Operations | $13,274 | $4,932 | N/A |
| Total Expenses (Net of Waivers) | $19,838 | $4,175 | N/A |
| Net Unrealized Depreciation | $(11,517) | $(1,627) | $(25,259) (Accumulated) |
| Cash and Cash Equivalents | N/A | N/A | $18,634 |
| Notes Payable (Total Debt) | N/A | N/A | $395,000 |
| Net Asset Value (NAV) per Share | N/A | N/A | $8.35 |
| Distributions Declared per Share | $0.52 | $0.52 | N/A |
Material Changes vs. Prior Period
- Portfolio Growth: Total portfolio investments at fair value increased by approximately 141% (from $363.7 million to $876.7 million) driven by significant capital raising and deployment of debt facilities.
- Revenue Surge: Net investment income increased 289% to $24.7 million, primarily due to the larger asset base and higher average borrowings.
- Expense Increase: Total expenses rose to $19.8 million from $4.2 million, reflecting higher management fees and interest expense associated with increased leverage.
- Unrealized Losses: Net unrealized depreciation increased significantly to $11.5 million (vs. $1.6 million prior year), driven by broad price declines in high-yield bond/leveraged loan markets and falling oil prices impacting energy sector holdings.
- NAV Decline: NAV per share decreased from $8.40 at year-end 2014 to $8.35 at September 30, 2015, despite positive operating income, due to the impact of unrealized depreciation.
Outlook, Risks, and Management Commentary
- Capital Resources: The company raised approximately $243.0 million in net proceeds during the nine-month period. As of September 30, 2015, $90.0 million of borrowing capacity remained available under credit facilities (Capital One and Deutsche Bank).
- Fee Waivers: The Adviser waived administrative services expenses ($1.4 million) and subordinated incentive fees ($1.4 million) for the period. The fee waiver agreement extends through December 31, 2015.
- Asset Quality: Three investments in two portfolio companies were placed on non-accrual status, representing approximately 0.3% of the total portfolio at fair value. The weighted average rating of the Lower Middle Market (LMM) portfolio remained at 3.0 (performing in accordance with expectations).
- Market Risks: The portfolio is sensitive to interest rate changes and credit market conditions. Approximately 84% of debt investments contain floating interest rates with floors, mitigating some downside risk from rate declines. However, rising rates could increase borrowing costs.
- Subsequent Events: In October and November 2015, the company decreased its public offering price from $9.90 to $9.55 per share to align with market conditions.
Investor Verification Checklist
- Distribution Coverage: Verify the source of distributions; while 99% of the $23.6 million distributed was covered by net realized income, the company notes it may fund distributions from borrowings or offering proceeds in the future.
- Non-Accrual Status: Review the specific portfolio companies on non-accrual status (Clarius BIGS, LLC and Relativity Media, LLC) and the potential for principal recovery.
- Leverage Ratio: Confirm the asset coverage ratio (210% as of Sept 30, 2015) remains compliant with the 200% minimum requirement under the Investment Company Act of 1940.
- Offering Price vs. NAV: Note the widening discount between the public offering price (reduced to $9.55) and the NAV ($8.35) and the implications for new capital inflows.
- Fee Waiver Expiration: Monitor the status of fee waivers and expense support agreements expiring December 31, 2015, and the potential for future fee reimbursement.